In late January, the IRS issued final regulations regarding the taxation of personal injury litigation damages. The regulations provide guidance regarding tax law changes included in the Small Business Job Protection Act passed in 1996.
- Litigation settlements are excluded from gross income for damages received on account of physical injuries or sickness.
- Damages from emotional distress should not be treated as a physical injury or sickness (and hence are taxable), except that damages paid for medical care attributable to emotional distress are excludible.
The final regulations are substantially the same as what was initially proposed, except for the elimination of the requirement that damages no longer need be based on “tort or tort type rights” in order to be excludible.